A Call From Within to Liberate Chinese and Indian Financial Markets

By

Matthew C. Klein

Jan. 24, 2019 11:42 a.m. ET

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Photograph by Jerome Favre/Bloomberg

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Technical reports on capital market structure are rarely political documents. Yet “Establishing Viable Capital Markets,” the latest publication from the Committee on the Global Financial System, is surprisingly punchy. Without naming names, it clearly criticizes government policies in China, India, and other major emerging markets for constraining competition, harming efficiency, and channeling resources to political patrons.

The critique is all the more noteworthy considering who wrote it: a working group led by Viral Acharya, the deputy governor of the Reserve Bank of India, and by Li Bo, the director general of the Monetary Policy Department at the People’s Bank of China. Both men were educated in the U.S. and both have worked there before their current jobs. (Acharya is on temporary leave from a faculty position at New York University’s Stern School of Business.)

Casual readers might easily miss the controversial aspects of the report. It starts with a lengthy introduction on the benefits of modern capital markets before presenting a wide range of statistics on everything from trading volumes in corporate bonds across countries to the relationship between regulatory protections for minority investors and equity market size. There are also sidebars on Australian foreign-exchange hedging, Brazilian derivatives markets, and initial public offerings in Italy, among others.

The authors do not present their policy recommendations until nearly 50 pages in. Some are relatively uncontroversial, such as encouraging greater financial literacy among savers. More significant, however, is the call for “greater respect for market autonomy” by ending “financial repression.” Governments should remove “paternalistic restrictions on IPO issuance to prop up stock market valuations,” “excessive requirements or incentives to hold government securities,” and “paternalistic substitution of the judgment of market participants to prevent losses.”

These are clear references to policies in both China and India.

The China Securities Regulatory Commission (CSRC), for example, strictly limits which companies can go public, how much they can raise, and the offering price of their new shares. Low-paid officials have broad discretion over large financial transactions, which creates abundant opportunities for corruption. Worse, those regulators can choke off the supply of new equity issuance in an attempt to boost stock prices, or favor particular sectors over others.

The report obliquely refers to this by noting that “some agencies have been guided by additional objectives, such as supporting government financing or containing market declines.” For years, Chinese officials have promised to reform the IPO process, yet they have still not done so.

Meanwhile, Indian banks and insurers have long been forced buyers of government debt thanks to regulations, although somewhat less so now than before the reforms of the 1990s. As the report notes, “a third of the stock of outstanding government bonds are effectively mandated to be held by banks.”

The report also argues for “bi-directional opening to international participation.” In other words, foreigners should be able to invest in local markets and local savers should be able to invest abroad. The Chinese government has long resisted this kind of openness and has generally imposed strict limits on how much money its subjects can take out of the country. The result is that most of China’s foreign assets are either held directly by the People’s Bank of China or by state-controlled banks and sovereign-wealth funds, rather than by private savers.

Until relatively recently, the Chinese government has also resisted foreign investment in Chinese assets, partly in an effort to control the currency and partly to maintain greater control of domestic market prices.

Over the past few years, Chinese regulators have tried to attract foreign investors to help prop up the value of the yuan, although foreigners still own less than 2% of Chinese stocks and bonds. The report suggests this has ultimately been bad for China, because “addressing foreign participants’ concerns [about regulatory quality and the rule of law] typically complements the domestic reform agenda and helps spur adoption of international best practices.”

The liberalization agenda pushed by Acharya and Bo is a laudable one. The question is whether their governments will accept the message.

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